One of the best options strategies, as far as income is concerned, is using covered calls. This strategy involves first buying or already owning a stock in round lots of 100 shares. You then enter into a contract to sell 100-share lots to another investor of that stock, if that stock closes at or above a specific price (strike price) on or before a given date (expiration date).
In exchange for selling this contract, you receive a payment called a “premium.” It’s known as a “covered call” because you’ve sold a “call contract,” meaning the stock could get sold, or called. It is “covered” because you actually own the stock itself (otherwise it would be “naked”).
You can earn a little extra income if you sell covered calls against dividend stocks that are going to pay dividends before the expiration date. Yes, the premium will be less than normal to adjust for the dividend, but I like this strategy because it diversifies where your income in coming from.
Covered Calls on Dividend Stocks: Lowe’s (LOW)
The first of these covered calls for dividend stocks is Lowe’s Companies, Inc. (NYSE:LOW).
The home improvement superstore is a bit pricey at 16x fiscal year 2017 earnings, but is the kind of stock I like to sell covered calls against because it’s a solid company in general. Should there be some market correction that takes LOW stock down to even $50, I would not be sad about owning it. It’s a great long-term play and I’d average down.
LOW stock pays a 35-cent dividend on Feb. 8 to holders of record on Jan. 25. Shares go ex-dividend on Jan. 23. LOW stock closed Wednesday at $71.26. You may consider selling the 10 Feb $71.50 covered calls for $1.25. Add in the dividend, and you end up with $1.60 per share. That’s a 2.25% return for a 30-day holding period, or about 27% annualized.
Covered Calls on Dividend Stocks: Stag Industrial (STAG)
Another interesting play for covered calls is a real estate investment trust (REIT) known as Stag Industrial Inc (NYSE:STAG). STAG is an industrial REIT that primarily owns warehouse and distribution properties and has been growing nicely since it went public in 2011.
It narrows its targets for purchases to those outside large industrial markets, focusing instead on secondary markets with long-term tenants. Particularly interesting for the covered calls seller is that STAG pays its dividend monthly. STAG pays 12 cents per share and the ex-dividend date is Jan. 27.
The stock closed Wednesday at $23.74, which puts us between the strike prices of $22.50 and $25. I frankly don’t see it going over $25, so I would suggest selling the 17 Mar $25 covered calls for 35 cents. You’ll get two dividends totaling 24 cents for a total return of 59 cents. That’s a 2.5% return for a 67-day holding period.
Covered Calls on Dividend Stocks: Pfizer (PFE)
I’m not a big fan of Pfizer Inc. (NYSE:PFE) as a company, but this is a case where a lumbering pharmaceutical giant has a fairly tight trading range that it has been stuck in for a very long time. The stock closed at $32.83 on Wednesday.
It has traded between about $28 and $37 over the past two years. So it won’t be terribly volatile. Should you end up holding it in a correction, it’s hardly the end of the world. PFE will be around forever, it just won’t grow very quickly.
The stock’s 32-cent dividend goes ex-dividend on Feb. 1. Even better, the 10 Feb $33 covered calls are selling for 58 cents. So take that, add in the 32-cent dividend, and add in another 27 cents in capital gains if it gets called away. That comes to $1.17 for a 30-day holding period, or a 3.56% return. That’s actually just under PFE stock’s entire annual yield, but you’ll earn it in thirty days.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
